When it Comes to Retirement, Timing is (Almost) Everything

This week, Gail tells you why it's time to re-think 'retirement.'

Attention Baby Boomers!

This may seem obvious, but the most important decision you will face about retirement is not how to invest your nest egg, how much you can safely withdraw, or what you’ll do with all the spare time you expect to have — it’s when to stop working.

A corollary to this is when to start receiving Social Security.

“When it comes to retirement, most of the ‘conventional wisdom’ is wrong,” according to Dr. Van Harlow, managing director of The Fidelity Research Institute.

For instance, take previous studies of the “safe” withdrawal rate, i.e. the amount you can withdraw from your nest egg each year and have a high probability that you will not run out of money. The conclusion: 3-4 percent in Year No. 1, increased each year after that by 3 percent, so your spending power keeps up with inflation.

Think about this for a minute. You’re finally retired. You’ve got a long list of things you want to do, have, and see. You’ve scraped and saved for 30 years of working to accumulate a nest egg worth $500,000. And the most you can take out your first year of retirement is $20,000?! In Year No. 2, it’s $20,600. Whoopee.

Oh, did I mention that for this to work a retiree has to invest 75-80 percent of his portfolio in stocks? Come on! How many seniors are going to be comfortable with so much of their money riding on the stock market?

Turns out, says Harlow, that the withdrawal rate a portfolio can safely sustain varies depending upon the age at which you start taking money from your account — the younger you are, the smaller the first year withdrawal rate has to be. Based on a more realistic portfolio consisting of 50 percent stocks, 40 percent bonds, and 10 percent cash, he found that someone who starts drawing from her nest egg at age 55 should not withdraw more than 3.12 percent the first year, while a retiree who begins withdrawals at age 75 can take out as much as 5.5 percent.

This is common sense! Assume two individuals will live to age 90. Retiree “A” begins drawing from his portfolio at age 55, while retiree “B” postpones his withdrawals until age 75. Since B’s account only has to last for 15 years, he can afford to take out more compared to A whose nest egg will have to last 35 years.

OK, so retiring at age 55 is a bit optimistic for most of us. In fact, the average age of retirement is still 62. There’s no mystery as to why: that’s the earliest age at which someone can begin receiving Social Security benefits.

In an encouraging development, in recent years we’ve started to see the retirement age slowly increase, indicating Americans are waiting slightly longer before they exit the workplace. Perhaps because it’s starting to dawn on people that they can’t afford to retire early and still enjoy the lifestyle they’ve hoped for. In fact, several studies indicate that for tomorrow’s retirees, the new retirement plan is to continue working at least part-time — maybe not in the same profession, but in “hobby jobs,” as financial advisor Kent Donley puts it.

Donley, an investment representative with Edward Jones in Olathe, Kansas, specializes in helping folks plan financially for retirement. In many cases, he says, he has to deliver bad news: a combination of too little savings and a longer life expectancy means a lot of folks won’t be able to afford to quit work completely if they want the freedom to enjoy the retirement they envisioned.

For those who find themselves coming up short in the “nest egg” department, Fidelity’s research found that “the decision to delay retirement, by even a few years, can make a big difference financially in the form of higher Social Security benefits, additional retirement plan contributions, and added growth potential for existing savings.”

Clearly, if you’ve got income coming in from a part-time job, you don’t need to withdraw as much from your retirement accounts. Leaving more money invested gives it additional time to grow to a larger amount. And, if you work enough hours to qualify, you may be able to build up some savings in the company retirement plan and even qualify for health insurance.

But one of the biggest boosts you can give your retirement income is to delay pulling the trigger on Social Security benefits.

Fidelity looked at a hypothetical individual, age 55 and earning $75,000 before taxes. Her “full” (also referred to as “normal”) retirement age — the age at which she is eligible to receive 100 percent of her Social Security benefit — is 66.

If this person stops working at age 62 and immediately begins taking Social Security, her first year’s benefit will be $15,888.. On the other hand, if she continues working until her 66th birthday and then applies for Social Security, her monthly checks will add up to $21,768 in Year No. 1. Waiting four years translates into 37 percent more income.

Let’s say this individual is healthy and continues to works until she turns 70 and then starts Social Security (the oldest age at which you can begin benefits). Her first year’s income will be $29, 436. Notice that this is exactly 32 percent more than her “full” benefit at age 66. It’s no accident: for every year beyond your full retirement age that you delay receiving Social Security, you’re guaranteed your benefit will increase by 8 percent/year. Wait four years (from age 66 to 70) and your Social Security checks will be nearly one third higher.

“If I put money in the stock market,” says Harlow, how often can I get 8 percent with certainty?” The answer: never. Put another way, if a bank were offering 4-year CDs paying 8 percent a year, retirees would form a line that stretched from Sun City to Leisure World in order to snag one.

What’s more, $29,436 is nearly twice the amount of annual income our retiree would receive if she opted for “early” Social Security benefits at age 62.

I know what you’re thinking: “But even though her checks were smaller, she collected benefits for 8 extra years.”

True. But the impact of a reduced benefit is compounded over time, so our “early” retiree rapidly begins to lose ground.* For instance, you know those annual cost-of-living (COLA) increases Social Security doles out? While the percentage is the same for everyone, the amount of dollars is not — it’s based on the size of your benefit.

In our example, a 3 percent COLA means our early retiree’s Social Security income would increase by $476.64 ($15,888 x 3 percent) in Year No. 2. If she waited until age 66 to start her benefit, a 3 percent COLA translates into $653.04 ($21,768 x 3 percent) more income the next year. The same percentage applied to benefits started up at age 70 results in an increase of $883.08 ($29,436 x 3 percent) the following year.

The key is the “crossover” point, which compares the benefits received at age 62 against the higher benefits received by starting at a later age to determine when the individual who postpones the onset of Social Security starts to pull ahead. You don’t have to wait until age 70 for the difference to be significant; starting Social Security at your “full” retirement age — when you’re eligible for 100 percent of your benefit — makes a tremendous difference.**

In our example, this occurs at about age 78. From that point on, benefits received by the retiree who waited a few extra years rapidly outstrip those collected by the individual who started at age 62. Take a look at the difference in the cumulative income our hypothetical retiree receives from Social Security by the time she is 85:

Start Social Security at age: ——————62———————- 66—————————(“Full”) 70

Total received age 85: ——————————-$365,424 ——-$413,592 —————-$441,540

Source: Fidelity Research Institute

Age 85 is significant. It represents the average life expectancy of a male who turn 65 this year.

The average life expectancy of a 65-year-old woman today is 88. But as the saying goes, if we’re just planning on living to the average life expectancy, there’s a 50 percent probability we’ll out-live our money because, by definition, half of us will live longer than “average.”

Delaying the onset of Social Security benefits — even by a few years — can result in significantly more income and greater financial security later in retirement.

Please save yourself the trouble of bombarding me with emails! I fully recognize that it is not always possible or advisable for someone to postpone the start of Social Security. If you need the income, this certainly isn’t an option. It’s also not recommended for someone whose life expectancy is likely to be curtailed by a life-threatening disease (cancer, for instance) or other condition that could shorten their life expectancy. Clearly, there needs to be a strong probability that you will live long enough to reap the rewards.

Another major consideration is what’s happening to your retirement nest egg. If the financial markets have been relatively strong and your savings are growing nicely, then living off your portfolio and delaying the onset of Social Security in order to boost the size of your monthly checks might be a viable option.

On the other hand, if the markets go into a swoon and your portfolio is taking a big hit, then it makes sense to start Social Security as soon as you can because every dollar in benefits you receive is a dollar less you have to withdraw from your nest egg. The nightmare scenario for a retiree involves having to take money out of their portfolio when it’s declined in value. As anyone who retired in 2000-2002 can tell you, you run the risk of withdrawing so much principal that your portfolio may never recover, even when the markets do.

Furthermore, I am fully aware of the projected shortfall Social Security is facing in the coming decades, but I’m not smart enough to guess if or how this will play out. However, when the extra money that has built up in the “trust fund” is exhausted, Social Security is not going to disappear. The millions of folks who will be in the workforce by then will be paying into the system. If nothing is done to amend the current rules, at that point Social Security projects it will still be able to pay out around 75-cents of every dollar in benefits currently promised to retirees. (Frankly, this is a great reason every one of us ought to be salting away our own private stash.)

The point is, Social Security is a valuable asset. The decision as to when to begin your benefits has significant and permanent consequences. It should not be taken lightly. Starting at age 62 simply “because I can” is the wrong criteria. If you are a member of the baby boom generation- born from 1946-1964- this will result in your benefit being cut by 25-30 percent compared to starting at your “full” retirement age (66-67).

This is where Donley’s “hobby job” comes into play. If they are physically able, increasingly individuals are choosing to keep working — and for variety of reasons other than the fact that they like the extra cash. Many cite the desire to be “useful,” the social interaction, the mental stimulus, and other factors. But instead of continuing to grind away, albeit for fewer hours, with their last employer, Donley says many are opting for a change of pace, a “fun” job that allows them to share their passion for a lifelong hobby or interest.

The “retired” software engineer who loves to fly fish may now work part-time at a sporting goods store. The “retired” school principal who always looked like a million bucks spends two days a week in a clothing store helping other women assemble outfits. The avid gardener provides valuable guidance for others through a job at the local nursery. The rewards of a semi-retired lifestyle go beyond the financial, says Donley. He finds that his happiest “retired’ clients are those who work two to three days a week.

Time to re-think “retirement.”

Hope this helps,

*The consequences are passed on to the surviving spouse: his/her spousal benefit is correspondingly reduced.

**You can run cross-over comparisons on yourself by going to the Social Security Web site and searching for “Retirement Calculators.”

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.